Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Perfect World (Nasdaq: PWRD ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let's take a closer look at Perfect World.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||102%||Pass|
|1-Year Revenue Growth > 12%||12.8%||Pass|
|Margins||Gross Margin > 35%||84%||Pass|
|Net Margin > 15%||30.3%||Pass|
|Balance Sheet||Debt to Equity < 50%||15.3%||Pass|
|Current Ratio > 1.3||1.75||Pass|
|Opportunities||Return on Equity > 15%||24.5%||Pass|
|Valuation||Normalized P/E < 20||5.15||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||8 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With eight points, Perfect World seems like it's heading toward making a new high score. But the online game company faces huge amounts of competition, and its fastest growth phase may be behind it.
Perfect World develops and operates massively multiplayer online role playing games, which have become a hot craze around the world but particularly within China. But unlike Activision Blizzard's (Nasdaq: ATVI ) World of Warcraft franchise, most of Perfect World's games are free to play. Where the company makes money is when players pay up to get upgrades for their characters, copying a page from peer Shanda Interactive's (Nasdaq: SNDA ) playbook.
But Perfect World is far from the only company seeking to take advantage of China's high-growth market. NetEase.com (Nasdaq: NTES ) , Giant Interactive (NYSE: GA ) , and Shanda Games (Nasdaq: GAME ) all managed to beat expectations during the most recent quarter. But Perfect World couldn't keep up the trend, as it not only fell short of expectations but also posted a year-over-year drop in per-share adjusted profits.
Even with weak results, however, the valuations on Perfect World and many of its peers are amazingly cheap. That's clearly what's behind the recent decision from Shanda Interactive to go private, and takeover activity could well boost shares of Perfect World in time as well. It may be a while before Perfect World pays a dividend, but even without reaching a top score of 10, the stock could bounce back well for investors if things start going right.
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.
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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."